February 5, 2008
China may yet be the economy to lose sleep over
By Kenneth Rogoff
Given the highly vulnerable state of the US and European economies, what would happen to global growth if the Chinese juggernaut also started sputtering? Few investors or policymakers seem to be seriously contemplating this scenario.
China’s remarkable resilience to both the 2001 global recession and the 1997-98 Asian financial crisis has convinced almost everyone that another year of double-digit growth is all but inevitable. In fact, the odds of a significant growth recession in China – at least one year of sub-6 per cent growth – during the next couple of years are 50:50. With Chinese inflation spiking, notable backpedalling on market reforms and falling export demand, 2008 could be particularly challenging.
The remainder of this column can be read here. Debate from our panel of economists appears below.
Jagdish Bhagwati: Ken Rogoff, one of my most distinguished “macro” students at MIT, and a fierce critic of rubbish on globalization - even when coming from Nobel Laureates stepping outside of their competence - has written a yet another thought-provoking essay.
I generally agree with him. No country growing rapidly has ever escaped short-run crises. China and India should be no exceptions. But what we do know is that, in the long run, countries that have embraced the magic formula of (i) a pragamtic approach to markets and public enterprises instad of knee-jerk interventions,(ii) openness to the world economy, and (iii) a democratic framework, have done well on a sustained basis, ironing out occasional difficulties.
On this criterion, India should do better because, while it has moved steadily if slowly in the direction of the first two sets of policies, it has always enjoyed a democratic framework. By contrast, China lacks one.
I think that Rogoff’s analysis needs to be supplemented by a fuller recognition of the problems that Chinese authoritarianism poses. Unless you have the institutions of a liberal democracy - a free press, NGOs, opposition parties and an independent judiciary - you run the danger of “social disruptions” that China has and you are unable to channel dissent and distress into creative political channels. This is why a big question mark hangs over China’s future.
I would also argue that Rogoff is too susceptible to the widespread assertions that inequality poses a big problem for China. Lack of democracy does. Mindless assertions that inequality between rural and urban areas, and between regions, and between the top 10% and the bottom 10% nationally are disruptive do not connect up these phenomena, even if correctly measured, to the unrest. I would argue that the authoritarian Chinese government has a vested interest in saying that it is economic inequality, rather than political authoritarianism, that is the problem: it lets them off the hook!
In India also, there is no evidence that inequality so measured has any political salience. What matters instead is the undoubted reduction of poverty which has made many of the poor come to finally believe that they can do still better: this is what I call the Revolution of Perceived Possibilities.
Posted by: Jagdish Bhagwati | February 5th, 2008 at 4:15 pm | Report this commentKenneth Rogoff: Jagdish Bhagwati, who I was fortunate enough to have as my professor at MIT, is absolutely right when he implies that the Indian economic and political system may prove more resilient on this occasion than China’s. This is partly because India is at an earlier and more robust stage of its business cycle, and partly because India is less open and therefore less vulnerable to the global slowdown. I do, however, think that income inequality is a central issue in China today. The explosion of inequality insidiously undermines the perceived legitimacy of the system, and it is not surprising that the authorities feel compelled to act to counterbalance the distributional effects of rapid growth.
Posted by: Kenneth Rogoff | February 5th, 2008 at 5:13 pm | Report this commentWilliam Easterly: Professor Rogoff is spot on about the serious possibility of China’s growth decelerating. Another more general body of evidence supports his argument - in the last 50 years, with the data we have on over 100 countries, episodes of rapid country growth are not uncommon but they have typically been short-lived. There is abundant statistical evidence for a force of gravity affecting country growth called “regression to the mean.” The historical tendency is that a country growing above the world average in one period (for example, a 5-year period or a decade) will move strongly back down towards the world average in the following period. Around 80 percent of a country’s excess growth above the world mean in one period disappears in the following period.
Growth forecasters are curiously oblivious of the overwhelming evidence for regression to the mean. Of course, a small number of countries can defy gravity for a while, as China has already done with the length of its current rapid growth episode. Until recently, the East Asian tigers (Hong Kong, Korea, Singapore, Taiwan) also defied gravity for an unusually long period, but in the last ten years gravity reasserted itself - their growth has decelerated back down towards world average growth.
Only diamonds are forever, rapid growth is transitory. Rogoff is right that China will learn this bitter lesson in the not too distant future.
Posted by: William Easterly | February 5th, 2008 at 5:19 pm | Report this commentPranab Bardhan: I think inequality often increases social resistance to market reform in democratic as well as authoritarian regimes. I agree with Ken Rogoff that rising inequality undermines regime legitimacy in China. But I’d add two qualifiers:
(a) Lack of democratic accountabilty makes the counterbalancing of the distributional effects of growth more difficult. There is some evidence that while the Chinese central leadership keeps on chanting the ‘harmonious society’ mantra, local officials, in cahoots with commercial developers, undercut efforts at curbing capitalist excesses and at building the social safety net, particularly in rural areas.
(b) One should not exaggerate the social effects of the rising rural-urban inequality in China. Data from a 2004 national survey in China, carried out by Harvard sociologist Martin Whyte and his team, show that the presumed disadvantaged in rural areas are not particularly upset by this inequality. This may have something to do with what Albert Hirschman once described as a ‘tunnel effect’; when you see other people prospering you are hopeful that your chance will soon come (you are more hopeful in a tunnel of blocked traffic when the next lane starts moving). This is particularly so with the relaxation of restrictions on migration from villages and improvements in roads and transportation.
Somewhat paradoxically, the potential for social unrest may be arguably greater in the currently booming urban areas of China, where, along with the breaking of the real estate bubble, a global recession could ripple through the excess-capacity industries and financially shaky public banks. With a more internet-connected and vocal middle class, a recent history of massive worker layoffs, and a large underclass of migrants, urban unrest could be more difficult to contain.
Posted by: Pranab Bardhan | February 5th, 2008 at 6:36 pm | Report this commentMartin Wolf: I am somewhat puzzled by Ken Rogoff’s line of argument.
It is obviously true that China will not grow at 10 per cent a year forever. But it is hard to argue that the potential for such rapid catch up on incomes in the high-income countries is exhausted. The latest World Bank estimates suggest that gross domestic product per head in China is only a tenth of US levels, at purchasing power parity. That surely leaves plenty of room for rapid catch up.
So if China’s growth is to slow sharply in the near future, there has to be some sort of disruption to the catch-up process. Indeed, Ken argues that the chances are as high as 50:50 that growth will slow to below 6 per cent, which is a little over half of current rates, in the next couple of years.
In support of this proposition he points to three dangers: inflation; protectionism; and inequality. All these are realistic concerns. But are they that likely to have such dramatic consequences in the near future? I doubt it.
Let us start at the back of the list, with inequality. Yes, inequality is indeed growing. But how could it prove so disruptive to growth in the very near future? One would have to envisage a wave of massive protests that disrupted political stability and the smooth workings of the economy. But China is a vast country with a powerful government backed by a powerful military. Organising large-scale opposition in such a country is very hard. While the breakdown in political order Ken seems to imply must be a possibility, I would have thought that the chances of its happening on a sufficiently large scale over a couple of years is quite small. And, of course, if the government were faced with such protests, it could offer carrots, since it has an extremely strong fiscal position, and would surely also wield a big stick.
Now let us turn to protection. Again, to disrupt growth in the next couple of years protection has to be massive and swift. There is not at present the slightest sign of protection sufficient to slow the growth of China’s exports (which remains immensely rapid), let alone cut them back. Moreover, even if China’s exports were to fall for a while (which I regard as virtually inconceivable), the country has a huge current account surplus (of about $360bn or 11 per cent of GDP last year) and gigantic foreign currency reserves (of about $1.5 trillion). Thus the government could easily sustain imports if it wished to do so. This being so, the short-term impact of any plausible increase in external protectionism on China’s growth is likely to be modest.
Finally, there is inflation. I accept that China’s inflation partly reflects the monetary consequences of the exchange-rate regime. (How far it does so is definitely a debatable proposition.) The solution is, of course, to accelerate the renminbi appreciation, which is exactly what China has done in recent months. That should certainly alleviate this danger. Furthermore, if one looks at the pattern of inflation, which is focused in foodstuffs, it is difficult to believe that tackling it would require a massive reduction in the growth of overall aggregate demand, particularly since most of that growth is being generated by investment, not consumption.
So I do not see how Ken can be confident that the risks of a massive shortfall in China’s growth are as great as 50:50. Far more likely, I believe, is a reduction of maybe two percentage points to, say, 9 per cent, which is exactly what the Chinese government would like happen.
I am not saying that China will growth at close to 10 per cent a year for another 20 years. As Bill Easterly argues, that would be extraordinary. It is also obvious that the country faces sizeable risks. It may well be true, too, that the political system is more brittle than India’s lumbering democracy. If, for such reasons, someone argued that there is, say, a 10 per cent chance of a significant disruption in any given year and so around a 90 per cent chance of a sizeable disruption at some point over two decades, I would find that quite plausible. But the big threats are internal, not external, and so largely unrelated to the global slowdown. And they certainly do not seem to me as imminent as Ken suggests.
Posted by: Martin Wolf | February 6th, 2008 at 8:05 pm | Report this commentKenneth Rogoff: Martin Wolf makes a number of excellent and sensible points, but I don’t share the same bottom line. Indeed, my main point was that the problems China faces at this conjuncture are largely internal. The incoming global slowdown is merely a potential catalyst. Many people have become convinced that because China has not yet experienced inflation, there are no important macroeconomic imbalances. In fact, China’s imbalances now pose a significantly greater threat than just a few years ago. Renimbi appreciation is indeed a long run solution to the inflation problem, but this channel is not nearly quick enough or strong enough to be sufficient in the short run. Monetary policy support is needed, and this channel is highly distorted, as I argue in my article. And yes, growing inequality matters a lot because the government has not yet formulated a clear idea of how to deal with the resulting political pressures, and therefore – as I argue – we may continued to see ad hoc measures that have the unintended consequence of exacerbating the already severe macroeconomic and financial imbalances.
Posted by: Kenneth Rogoff | February 7th, 2008 at 11:51 am | Report this commentAnne Krueger: Ken Rogoff rightly argues that China faces multiple economic problems - inflationary pressure, growing inequality, and stalled reforms among them. He also notes that emerging markets in general have been unable to avoid financial crises.
There can be no denying that a slowdown - perhaps a “growth recession” - could occur as a result of efforts to contain inflation or for other reasons, including a less buoyant world economy. But if it is the latter, the Chinese have more than enough domestic projects (some perhaps with low rates of return) to offset any drop in export demand.
However, if it were a result of domestic macroeconomic restraints, one can question how large the spillover to the world economy would be. The main transmission mechanisms would be the impact of any such growth recession on Chinese imports and, possibly on capital inflows. Should Chinese demand for imports grow less rapidly, the chief effect would be to reduce the growth of demand for commodities, especially oil. If that resulted in lower commodity prices, the primary effect would be to offset some of the reduction in aggregate demand in oil importing countries, while most commodity exporters have accumulated sufficient reserves so that they would likely not be confronted with the need to constrain their imports that has accompanied past recessions.
Meanwhile, tightening macro policies to restrain inflationary pressures in China and/or a reduced growth rate if done through market mechanisms would probably lead to smaller inflows.
But both of these effects would contribute, at least somewhat, to correcting global imbalances and would have little effect on aggregate demand in the rest of the world. The spillovers from a Chinese growth recession would therefore be somewhat less than would at first sight appear. Of course, if demand for Chinese exports dropped because of a slowdown in the rest of the world, that could spill over into other Asian countries that export to China. But that would be a knock-on from global slowdown, not the direct effect of the level of Chinese economic activity.
Certainly, Ken is right in pointing to the risks of a Chinese slowdown and calling for an improved social safety net and marked-based reforms. The spillovers from a Chinese growth recession, however, would likely be somewhat smaller than at first sight would appear.
Posted by: Anne Krueger | February 8th, 2008 at 9:53 am | Report this commentTim Young (guest): China’s currency policy need not be a source of inflation. If the authorities struggle to sell sterilisation bonds at an acceptable yield, the state can always sell some of its huge industrial stakes instead. The state holding of PetroChina alone is worth over $500bn; more than enough to completely sterilise another year’s reserves accumulation at the recent pace.
Posted by: Tim Young | February 8th, 2008 at 4:25 pm | Report this commentTim Young seems to me to be right. Of course, that makes the external surplus sustainable more or less indefinitely. This is not good news for those who believe that this is a part of the explanation for the present financial woes.
Posted by: Martin Wolf | February 11th, 2008 at 5:02 pm | Report this comment